DIFFERENT ECONOMICS STABILIZATION PACKAGES ADOPTED BY NIGERIA, UK AND, US

ABSTRACT  

Generally, both fiscal and monetary policies seek at achieving relative macroeconomic stability. Based on countries’ experience on the role of monetary policy in controlling economics instability, this study examines the efficacy of monetary policy in controlling inflation rate and exchange rate instability. The analysis performed is based on a rational expectation framework that incorporates the fiscal role of exchange rate. Using quarterly data spanning over 1980: 1 to 2000: 4, and applying time series test on the data used, the paper shows that the effort of monetary policy at influencing the finance of government fiscal deficit through the determination of the inflation tax rate affects both the rate of inflation and the real exchange rate, thereby causing volatility in their rates. The paper reveals that inflation affects volatility of its own rate, as well as the rate of real exchange. The policy import of the paper is that monetary policy should be set in such a way that the objective it is to achieve is well defined. 

A Broad View of Macroeconomic Stability

The concept of macroeconomic stability has undergone considerable changes in the economic discourse over the past decades. During the post-war years dominated by Keynesian thinking, macroeconomic stability basically meant a mix of external and internal balance, which in turn implied, in the second case,full employment and stable economic growth, accompanied by low inflation. Over time, fiscal balance and price stability moved to center stage, supplanting the Keynesian emphasis on real economic activity. This policy shift led to the downplaying and even, in the most radical views, the complete suppression of the counter-cyclical role of macroeconomic policy. Although this shift recognized that high inflation and unsustainable fiscal deficits have costs, and that “fine tuning” of macroeconomic policies to smooth out the business cycle has limits, it also led to an underestimation of both the costs of real macroeconomic instability and the effectiveness of Keynesian aggregate demand management. This shift was particularly sharp in the developing world, where capital account and domestic financial liberalization exposed developing countries to the highly pro-cyclical financial swings characteristic of assets that are perceived by fi financial markets as risky, and thus subject to sharp changes in the “appetite for risk”. In the words of Stigmatize (2002), such exposure replaced Keynesian automatic stabilizers with automatic destabilizes. Thus, contrary to the view that financial markets would play a disciplining role, dependence on financial swings actually encouraged the adoption of pro-cyclical monetary and fiscal policies that increased both real macroeconomic instability and the accumulation of risky balance sheets during periods of financial euphoria which led, in several cases, to financial meltdowns. There is now overwhelming evidence that pro-cyclical financial markets and pro-cyclical macroeconomic policies have not encouraged growth; they have in fact increased growth volatility in developing countries that have integrated to a larger extent in international financial markets (Prasad and others, 2003). This has generated a renewed but still incomplete interest in the role that counter-cyclical macroeconomic policies can play in smoothing out—that is, in reducing the intensity of—business cycles in the developing world. At the same time, since the Asian crisis, recognition has grown that liberalized capital accounts and financial markets tend to generate excessively risky private sector balance sheets, and that an excessive reliance on short-term external financing enhances the risks of currency crises. Preventive (prudential) macroeconomic and financial policies, which aim to avoid the accumulation of unsustainable public and private sector debts and balance sheets during periods of financial euphoria, have thus become part of the standard recipe since the Asian crisis. This represents, however, only a partial return to a counter- cyclical macroeconomic framework, for no equally strong consensus has yet emerged on the role of expansionary policies in facilitating recovery from crises.

Thus, the menu of macroeconomic policies has broadened in recent years. We have only come

part of the way, however, to the full recognition that macroeconomic stability involves multiple dimensions, including not only price stability and sound fiscal policies, but also a well-functioning real economy,sustainable debt ratios, and healthy domestic financial and non-financial private sector balance sheets.

A well-functioning real economy requires, in turn, smoother business cycles, moderate long-term interest

rates and competitive exchange rates, all of which may be considered intermediate goals of the ultimate

Keynesian objective: full employment. Such a broad view of macroeconomic stability should recognize,

in any case, that there is no simple correlation between its various dimensions and, thus, that multiple

objectives and significant trade-offs are intrinsic to the design of “sound” macroeconomic frameworks.

This view should lead to the recognition of the role played by two sets of policy packages, whose

relative importance will vary depending on the structural characteristics, the macroeconomic policy tradition

and the institutional capacity of each country. The first involves a mix of counter-cyclical fiscal and

monetary policies with appropriate (and, as we will argue, generally intermediate) exchange-rate regimes.

The second includes a set of capital management techniques designed to reduce the unsustainable accumulation

of public and private sector risks in the face of pro-cyclical access to international capital markets.

To encourage economic growth, such interventions through the business cycle should lead to

sound fiscal systems that provide the necessary resources for the public sector to do its job, a competitive

exchange rate and moderate long-term real interest rates. These conditions, together with deep financial

markets that provide suitably priced investment finance in the domestic currency with sufficiently long

maturities, are the best contribution that macroeconomics can make to growth.

This paper calls for a broad view of macroeconomic stability and for active counter-cyclical macroeconomic

policies supported by the equally active use of capital management techniques. It is divided into

four sections. The first section identifies some “stylized facts” about financial and real macroeconomic instability

in developing countries. The subsequent two sections each analyze one of the a fore-mentioned policy

packages. The last takes a brief look at the implications of this framework for international cooperation.

 

  The role of government in the American economy extends far beyond its activities as a regulator of specific industries. The government also manages the overall pace of economic activity, seeking to maintain high levels of employment and stable prices. It has two main tools for achieving these objectives: fiscal policy, through which it determines the appropriate level of taxes and spending; and monetary policy, through which it manages the supply of money.

Much of the history of economic policy in the United States since the Great Depression of the 1930s has involved a continuing effort by the government to find a mix of fiscal and monetary policies that will allow sustained growth and stable prices. That is no easy task, and there have been notable failures along the way.

But the government has gotten better at promoting sustainable growth. From 1854 through 1919, the American economy spent almost as much time contracting as it did growing: the average economic expansion (defined as an increase in output of goods and services) lasted 27 months, while the average recession (a period of declining output) lasted 22 months. From 1919 to 1945, the record improved, with the average expansion lasting 35 months and the average recession lasting 18 months. And from 1945 to 1991, things got even better, with the average expansion lasting 50 months and the average recession lasting just 11 months.

Inflation, however, has proven more intractable. Prices were remarkably stable prior to World War II; the consumer price level in 1940, for instance, was no higher than the price level in 1778. But 40 years later, in 1980, the price level was 400 percent above the 1940 level.

In part, the government's relatively poor record on inflation reflects the fact that it put more stress on fighting recessions (and resulting increases in unemployment) during much of the early post-war period. Beginning in 1979, however, the government began paying more attention to inflation, and its record on that score has improved markedly. By the late 1990s, the nation was experiencing a gratifying combination of strong growth, low unemployment, and slow inflation. But while policy-makers were generally optimistic about the future, they admitted to some uncertainties about what the new century would bring.

FISCAL POLICY VS MONETARY POLICY

  Fiscal policy and monetary policies are instruments utilized by governments to give impetus to the economy of a nation and sometimes they are used to curb the excess growth. The fiscal policy is the underlying principle through which the government controls the economy with the collection and expenditure of money. This is revealed in the government’s fiscal policy of a particular period.

The government engages in manipulating the available fund within the economy. This is described in the monetary policy of the government. It deals with the issuing of currency and administration of banks for smooth operations. A good flow of money enables customers to have more cash at hand and in turn encourages spending. The fiscal policy relates with the programs and plans of the government and creates an increasing demand for workers resulting in lowering of unemployment position. The automatic fiscal plans correct the sliding down of economy, like the unemployment insurance to give relief to persons who lose jobs. Tax cuts are brought in to give back more money to business and consumers which they can spend in turn to strengthen the economy.

The fiscal policy revolves around the economic position of the nation and the related strategy to impose taxes to make maximum use of fund. This is not a one time affair but goes on changing every year to suit the position of the economy and its needs during the specific period.

The monetary policy differs with the fiscal policy on the ground that it is exclusively for banks and the circulation of money in an efficient way. This is also changed every year on the demand and supply of the money and makes effect on the rate of interest on loans. This monetary policy acts as the key regulator through the key bank of the nation as the Federal Reserve System in US.

Fiscal policy is fundamentally an attempt of the nation to give direction to the economy through manipulation of tax structures. Whereas, the monetary policy is the procedure by which the nation or its key bank influences the supply of fund, rates of interest and so on. The main objectives of both the procedures are attainment of growth of economy and its stability.

In the monetary policy, the central bank attempts to bring in four principles to either increase or reduce money supply to make a change in the structure. The primary principle is to change the cash reserve ratio of commercial banks. This restraint compels banks to maintain a deposit at the central bank. The increase s difficult. Accordingly interest rates on short-term borrowings are settled. The central banks also employ the process of buying or selling of government bonds to control the supply of money in the market. These are basic differences between fiscal policy and monetary policy of a country.

Summary
1. Fiscal policy gives the direction of economy of a nation. Monetary policy controls the supply of money in the nation.
2. Fiscal policy relates to the economic position of a nation. Monetary policy focuses on the strategy of banks.
3. Fiscal policy administers the taxation structure of the nation. Monetary Policy helps to stabilize the economy of the country.
4. Fiscal policy speaks of the government’s economic program. Monetary policy sets the program of key banks of the nation.

I. THE BUSINESS CYCLE 
Market economies have regular fluctuations in the level of economic activity which we call the business cycle. It is convenient to think of the business cycle as having three phases. The first phase is expansion when the economy is growing along its long term trends in employment, output, and income. But at some point the economy will overheat, and suffer rising prices and interest rates, until it reaches a turning point -- a peak -- and turn downward into a recession (the second phase). Recessions are usually brief (six to nine months) and are marked by falling employment, output, income, prices, and interest rates. Most significantly, recessions are marked by rising unemployment. The economy will hit a bottom point -- a trough -- and rebound into a strong recovery (the third phase). The recovery will enjoy rising employment, output, and income while unemployment will fall. The recovery will gradually slow down as the economy once again assumes its long term growth trends, and the recovery will transform into an expansion.

Generally, both fiscal and monetary policies seek at achieving relative macroeconomic stability.Over the year, two issues have been subjects ofdebate in this regard. First is the superiority ofeach of these policies in the achievement of macroeconomic stability. While the Keynesians argued that fiscal policy is more potent than monetary policy, the monetarists led by Milton Friedman on the other hand believed the other way round. Although the focus of this paper is neither to join in nor extend the debate, based on countries’ experience and the fact that monetary policy is often free from political interference, the study analyses how effective monetary policy

has been in tackling macroeconomic instability in Nigeria. The second issue concerns the definition of macroeconomic instability. Macroeconomic instability can be regarded as a situation of economic malaise, where the economy does not seem to have settled in a steady equilibrium position (Azam, 2001), thereby making it difficulty to make predictions and good planning. The definition of macroeconomic instability above suffers from lack of precision. The monetary policy focuses precisely on the achievement of price stability, with respect to both domestic and external prices. While inflation rate is often used to track movement in domestic price level, exchange rate is used as policy tool in

II. ECONOMIC POLICY AND THE BUSINESS CYCLE  
The approach to the business cycle depends upon the type of economic system. Under a communist system, there is no business cycle since all economic activities are controlled by the central planners. Indeed, this lack of a business cycle is often cited as an advantage of a command economy. Both socialist and fascist economies have a mix of market and command sectors. Again, the command sector in these economies will not have a business cycle while the market sector will display a cyclical activity. In a full market economy -- like the United States the nation can suffer extreme swings in the level of economic activity. The economic policies used by the government to smooth out the extreme swings of the business cycle are called contra cyclical or stabilization policies, and are based on the theories of John Maynard Keynes. Writing in 1936 (the Great Depression), Keynes argued that the business cycle was due to extreme swings in the total demand for goods and services. The total demand in an economy from households, business, and government is called aggregate demand. Contra cyclical policy is increasing aggregate demand in recessions and decreasing aggregate demand in overheated expansions. In a market economy (or market sector) the government has two types of economic policies to control aggregate demand -- fiscal policy and monetary policy. When these policies are used to stimulate the economy during a recession, it is said that the government is pursuing expansionary economic policies. And when they are used to contract the economy during an overheated expansion, it is said that the government is pursuing contractionary economic policies.

III. FISCAL POLICY AND MONETARY POLICY

1) Discretionary Fiscal Policy. Fiscal policy is changes in the taxing and spending of the federal government for purposes of expanding or contracting the level of aggregate demand. In recession, an expansionary fiscal policy involves lowering taxes and increasing government spending. In an overheated expansion, a contractionary fiscal policy requires higher taxes and reduced spending. The first way this can be done is through the federal budget process. However, this process takes so long -- 12 to 18 months -- that discretionary fiscal policy cannot be matched with the business cycle. The Kennedy tax cut of 1964 and later the Ford tax increase of 1974 hit the economy just when the opposite contra cyclical policy was needed. As a result, the federal government no longer uses discretionary fiscal policy.2) Automatic Stabilizers. A second type of fiscal policy is built into the structure of federal taxes and spending. This is referred to as "nondiscretionary fiscal policy" or more commonly as "automatic stabilizers". The progressive income tax (the major source of federal revenue) and the welfare system both act to increase aggregate demand in recessions, and to decrease aggregate demand in overheated expansions.3) Monetary Policy. Monetary policy is under the control of the Federal Reserve System (our central bank) and is completely discretionary. It is the changes in interest rates and money supply to expand or contract aggregate demand. In a recession, the Fed will lower interest rates and increase the money supply. In an overheated expansion, the Fed will raise interest rates and decrease the money supply. These decisions are made by the Federal Open Market Committee (FOMC) which meets every six to seven weeks. The policy changes can be done immediately, although the impact on aggregate demand can take several months. Monetary policy has become the major form of discretionary contra cyclical policy used by the federal government. A source of conflict is that the Fed is independent and is not under the direct control of either the President or the Congress. This independence of monetary policy is considered to be an important advantage compared to fiscal policy. Note that expansionary monetary policy is commonly called "easy money" while contractionary monetary policy is called "tight money". Other terms are also used. 

Read more: Difference Between Fiscal and Monetary policy | Difference Between http://www.differencebetween.net/business/difference-between-fiscal-and-monetary-policy/#ixzz0ucMepiuM

References

Ariyoshi, Akira, Karl Habermeier, Bernard Laurens, Inci Ötker-Robe, Jorge Iván Canales-Kriljenko, and Andrei Kirilenko (2000).

Capital Controls: Country Experiences with Their Use and Liberalization. Occasional Paper No. 190, International

Monetary Fund, Washington, D.C.

BIS (2001). 71st Annual Report. June, Bank for International Settlements, Basel.

Bordo, Michael, Barry Eichengreen, Daniela Klingebiel and María Soledad Martínez-Peria (2001). Is the Crisis Problem

Growing More Severe?. Economic Policy 32, April: 51-82.

Borio, Claudio, Craig Furfi ne and Philip Lowe (2001). Pro-cyclicality of the Financial System and Financial Stability: Issues and

Policy Options. In Marrying the Macro- and Micro-Prudential Dimensions of Financial Stability. BIS Paper No. 1,

March, Bank for International Settlements, Basel: 1-57.

Braga de Macedo, Jorge, Daniel Cohen and Helmut Reisen (eds) (2001). Monetary Integration for Sustained Convergence:

Earning Rather than Importing Credibility. In Jorge Braga de Macedo, Daniel Cohen and Helmut Reisen (eds). Don’t

Fix, Don’t Float. OECD Development Centre Studies, Paris: 11-53.

Calvo, Guillermo (2001). The Case for Hard Pegs in the Brave New World of Global Finance. In Jorge Braga de Macedo, Daniel

Cohen and Helmut Reisen (eds). Don’t Fix, Don’t Float. OECD Development Centre Studies, Paris: 77-84.

Calvo, Guillermo, Leonardo Leiderman, and Carmen Reinhart (1993). Capital Infl ows and Real Exchange Rate Appreciation in

Latin America: The Role of External Factors. IMF Staff Papers 40, March: 108-151.

Calvo, Guillermo, and Ernesto Talvi (2004). Sudden Stop, Financial Factors and Economic Collapse: A View from the Latin

American Frontlines. Paper presented in the Universal Forum for Cultures, Barcelona, September.

Clerc, Laurent, Françoise Drumetz and Oliver Jaudoin (2001). To What Extent are Prudential and Accounting Arrangements

Pro- or Counter-cyclical with Respect to Overall Financial Conditions?. In Marrying the Macro- and Micro-Prudential

Dimensions of Financial Stability. BIS Paper No. 1, March, Bank for International Settlements, Basel: 197-210.

Davis, Jeffrey, Rolando Ossowski, James A. Daniel and Steven Barnett (2003). Stabilization and Savings Funds for

Nonrenewable Resources: Experience and Fiscal Policy Implications. In Jeffrey Davis, Rolando Ossowski and Annalisa

Fedelino (eds). Fiscal Policy Formulation and Implementation in Oil-Producing Countries. International Monetary

Fund, Washington, DC: Chapter 11.

De Gregorio, José, Sebastián Edwards and Rodrigo Valdés (2000). Controls on Capital Infl ows: Do They Work?. Journal of

Development Economics 63 (1), October: 59-83.

Díaz-Alejandro, Carlos F. (1988). Trade, Development and the World Economy: Selected Essays. Andrés Velasco (ed.). Basil

Blackwell, Oxford.

Dodd, Randall, and Shari Spiegel (2004). Up From Sin: A Portfolio Approach to Salvation. Paper prepared for the XVIII

Technical Group Meeting of the Group of 24, Geneva, March.

Easterly, William (2001). The Elusive Quest for Growth. MIT Press, Cambridge, MA.

Easterly, William, Roumeen Islam and Joseph E. Stiglitz (2001). Shaken and Stirred: Explaining Growth Volatility. In Boris

Pleskovic and Nicholas Stern (eds). Annual Bank Conference on Development Economics 2000. World Bank,

Washington, DC: 191-212.